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    Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Second Canadian Edition

    CHAPTER 2

    A Further Look at Financial Statements

    ASSIGNMENT CLASSIFICATION TABLE

    Study Objectives QuestionsBrief

    Exercises ExercisesA

    ProblemsB

    Problems

    1. Describe the basicobjective of financialreporting, and thequalitativecharacteristics ofaccounting information.

    1, 2, 3 1, 2, 1A 1B

    2. Identify the twoconstraints inaccounting.

    4, 5 3 2A 2B

    3. Identify the sections of aclassified balance sheet.

    6, 7, 8, 9 4, 5 1, 2, 3, 4,5

    3A, 4A, 5A,6A

    3B, 4B, 5B,6B

    4. Identify and calculateratios for analysing a

    company's profitability.

    10, 12, 13,14, 15, 16

    6 6 7A, 8A, 9A,10A

    7B, 8B, 9B,10B

    5. Explain the relationshipbetween a statement ofretained earnings, astatement of earnings,and a balance sheet.

    11 7 5 5A, 6A 5B, 6B

    6. Identify and calculateratios for analysing acompany's liquidity and

    solvency.

    12, 13, 14,15, 16

    8 7, 8 7A, 8A, 9A.10A

    7B, 8B, 9B,10B

    Solutions Manual 2-1 Chapter 2

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    ASSIGNMENT CHARACTERISTICS TABLE

    ProblemNumber Description

    DifficultyLevel

    TimeAllotted (min.)

    1A Comment on objective and qualitativecharacteristics of financial reporting. Moderate 20-30

    2A Comment on the constraints of accounting. Moderate 10-20

    3A Classify accounts. Simple 10-20

    4A Prepare classified balance sheet. Moderate 10-20

    5A Prepare financial statements. Moderate 20-30

    6A Prepare financial statements and discussrelationships. Moderate 20-30

    7A Calculate ratios and comment on profitability,liquidity, and solvency.

    Moderate 20-30

    8A Calculate profitability, liquidity, and solvency ratios. Simple 10-20

    9A Calculate profitability, liquidity, and solvency ratiosand discuss results.

    Moderate 15-25

    10A Calculate profitability, liquidity, and solvency ratios

    and discuss results.

    Moderate 15-25

    1B Comment on the objective and qualitativecharacteristics of accounting information.

    Moderate 20-30

    2B Comment on the constraints of accounting. Moderate 10-20

    3B Classify accounts. Simple 10-20

    4B Prepare classified balance sheet Moderate 10-20

    5B Prepare financial statements. Moderate 20-30

    6B Prepare financial statements and discussrelationships

    Moderate 20-30

    7B Calculate ratios and comment on profitability,liquidity, and solvency.

    Moderate 20-30

    Solutions Manual 2-2 Chapter 2

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    Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Second Canadian Edition

    ProblemNumber Description

    DifficultyLevel

    TimeAllotted (min.)

    8B Calculate profitability, liquidity, and solvency ratios. Simple 10-20

    9B Calculate profitability, liquidity, and solvency ratiosand discuss results.

    Moderate 15-25

    10B Calculate profitability, liquidity, and solvency ratiosand discuss results. Moderate 15-25

    Solutions Manual 2-3 Chapter 2

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    Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Second Canadian Edition

    ANSWERS TO QUESTIONS

    1. (a) Generally accepted accounting principles (GAAP) are a set of rules and practices,having substantial support, that are recognized as a general guide for financialreporting purposes.

    (b) The primary objective of financial reporting is to provide information useful fordecision-making.

    (c) The qualitative characteristics are (1) understandability, (2) relevance,(3) reliability, and (4) comparability.

    2. Erhardt is correct. Consistency means using the same accounting principles andaccounting methods from period to period within a company. Without consistency in theapplication of accounting principles, it is difficult to determine whether a company isbetter off, worse off, or in the same position from period to period. When a change ismade in accounting principles or methods a company is required to disclose informationabout the change.

    3. Comparability results when different companies use the same accounting principles.Consistency means using the same accounting principles and methods from year to yearwithin the same company.

    4. The two constraints are cost-benefit and materiality. The cost-benefit constraint meansthat information will be presented only when the benefit associated with it exceeds thecost of producing it. The materiality constraint means that an item may be so small thatfailure to follow generally accepted accounting principles will not influence the decision ofa reasonably prudent investor or creditor.

    5. The accountant is correct in saying that the rounded financial figures provide usefulinformation to external users for decision making. This is supported by the concept ofmateriality. When investors are making decisions they are not concerned with immaterialdollar values or cents. In fact, presenting rounded information may make it easier forinvestors to focus on the big picture.

    6. Current assets are cash and other resources that are reasonably expected to be realizedin cash or sold or consumed in the business within one year of the balance sheet date orthe company's operating cycle, whichever is longer. Current assets are listed in the orderof liquidity. That is, in the order in which they are expected to be converted into cash.

    7. Long-term investments are generally investments in debt and equity of othercorporations that are normally held for many years. They also include investments in

    long-term assets such as land and buildings that are not currently being used in theorganizations operating activities. Intangible assets are assets that do not have anyphysical substance and yet add value to the company. Intangible assets include itemssuch as trademarks, copyrights and goodwill.

    Solutions Manual 2-4 Chapter 2

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    Questions (Continued)

    8. The major differences between current liabilities and long-term liabilities are:

    DifferenceSource of

    payment.

    Current LiabilitiesExisting current assets or

    other current liabilities.

    Long-term LiabilitiesOther than existing

    current assets or creatingcurrent liabilities.

    Time of expectedpayment.

    Within one year or theoperating cycle.

    Beyond one year or theoperating cycle.

    Nature of items. Debts pertaining to theoperating cycle and othershort-term debts.

    Mortgages, bonds andother long-term liabilities.

    9. The two parts of shareholders' equity and the purpose of each are: (1) Share capital is

    used to record investments of assets in the business by the owners (shareholders). Ifthere is only one class of shares it is known as common shares. (2) Retained earningsis used to record net earnings retained in the business.

    10. Amod is correct. A single ratio by itself may not be very meaningful and is bestinterpreted by comparison with (1) past ratios of the same enterprise, (2) ratios of otherenterprises, or (3) industry norms or predetermined standards. In addition, other ratios ofthe enterprise are necessary to determine overall financial well being.

    11. The statement of retained earnings is interrelated with both the statement of earningsand the balance sheet. The statement of earnings reports the net earnings for the

    period. This figure is then used in the statement of retained earnings, along withdividends to calculate the amount of retained earnings at the end of the period. Theretained earnings figure is used in the balance sheet to complete the accountingequation.

    12. (a) Tia is not correct. There are three characteristics: liquidity, profitability, andsolvency.

    (b) The three parties are not primarily interested in the same characteristics of acompany. Short-term creditors are primarily interested in the liquidity of theenterprise. In contrast, long-term creditors and shareholders are primarilyinterested in the profitability and solvency of the company.

    13. (a) Liquidity ratios: Working capital, current ratio, and cash current debt coverage.(b) Solvency ratios: Debt to total assets and cash total debt coverage.(c) Profitability ratios: Earning per share and price-earnings ratio.

    Solutions Manual 2-5 Chapter 2

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    Questions (Continued)

    14. (a) Liquidity ratios measure the short-term ability of the enterprise to pay its maturingobligations and to meet unexpected needs for cash.

    (b) Profitability ratios measure the earnings or operating success of an enterprise fora given period of time.

    (c) Solvency ratios measure the company's ability to survive over a long period oftime.

    15. (a) An increase in earnings per share usually signals good new for the companybecause higher EPS will generally indicate to investors that the company isproviding them with a higher return on their investment. This will cause thecompanys shares to become more attractive and hopefully increase in price.

    (b) An increase in the current ratio usually signals good news because the companyimproved its ability to meet maturing short-term obligations. It can also mean thatsome of the components of the current ratio (e.g. Accounts receivable, inventory)are slow moving. Further investigation is usually necessary to ensure that this is

    not the case.(c) The increase in the debt to total assets ratio is bad news because it means that

    the company has increased its obligations to creditors and has lowered its equity"buffer."

    (d) A decrease in the cash current debt coverage ratio usually signals bad news forthe company because it means the company has been able to generate less cashto meet its short-term obligations.

    16. (a) The debt to total assets ratio and cash total debt coverage ratio which indicate thecompany's ability to repay the face value of the debt at maturity and periodicinterest payments.

    (b) The current ratio, working capital, and cash current debt coverage, which indicatea company's liquidity and short-term debt-paying ability.

    (c) The earnings per share ratio and the price-earnings ratio. The earnings per sharemeasures the net earnings earned on each common share and the price-earningsratio measures the relationship between the market price per share and theearnings per share.

    Solutions Manual 2-6 Chapter 2

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    SOLUTIONS TO BRIEF EXERCISES

    BRIEF EXERCISE 2-1

    (a) General business and economic conditions(b) Predictive value(c) Feedback value(d) Verifiable(e) Conservative(f) Different companies use similar accounting principles

    BRIEF EXERCISE 2-2

    (a) 1. Predictive value.(b) 2. Neutral.(c) 3. Verifiable.(d) 4. Timely

    BRIEF EXERCISE 2-3

    (a) Cost-Benefit.(b) Materiality.(c) Materiality.

    BRIEF EXERCISE 2-4

    CL Accounts payable CL Income tax payableCA Accounts receivable LT I Investment in long-term bondsPPE Accumulated amortization PPE LandPPE Building CA Merchandise inventoryCA Cash IA PatentIA Goodwill C A Supplies

    Solutions Manual 2-7 Chapter 2

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    BRIEF EXERCISE 2-5

    SWANN LIMITEDBalance Sheet (Partial)

    Current assets

    Cash $18,400Short-term investments 8,200

    Accounts receivable 16,500Supplies 5,200Prepaid insurance 3,600

    Total current assets $51,900

    BRIEF EXERCISE 2-6

    (a)

    2002 2001

    Earnings per share:

    shares19,956

    $38,520

    = $1.93 per share

    Earnings per share:

    shares19,926

    $36,323

    = $1.82 per share

    Price-earnings ratio:

    $1.93

    $30.88= 16 times

    Price-earnings ratio:

    $1.82

    $23.00= 12.6 times

    (b)

    Given that the number of common shares outstanding increased during the year, the increasein earnings per share would indicate that profitability has improved in 2002. As well, investorsappear to have more confidence in Leons earnings as indicated by the increase in the price-earnings ratio in 2002.

    Solutions Manual 2-8 Chapter 2

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    BRIEF EXERCISE 2-7

    Share Capital Retained Earnings

    a. Issued common shares + NE

    b. Paid a cash dividend NE -c. Reported net earnings NE +d. Paid cash to creditors NE NEe. Issued preferred shares + NE

    BRIEF EXERCISE 2-8

    (a) Current ratio

    $293,625$252,787 = 0.86:1

    (b) Debt to total assets

    $439,832

    $376,002= 85.5%

    (c) Cash current debt coverage

    +

    2

    $240,819$293,625

    $(2,574)

    = (0.009) times

    Solutions Manual 2-9 Chapter 2

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    SOLUTIONS TO EXERCISES

    EXERCISE 2-1

    C L Accounts payable and CA Inventoriesaccrued liabilities LTI Investments

    CA Accounts receivable PPE LandPPE Accumulated amortization LTL Long-term debtPPE Buildings CA Materials and suppliesCA Cash and temporary investments PPE Office equipment and furnitureCL Dividends payable SC Preferred sharesIA Goodwill CA Prepaid expenses and other CA Income taxes receivable

    EXERCISE 2-2

    JUMBO ENTERTAINMENT INC.Balance Sheet

    February 28, 2003

    AssetsCurrent assets

    Cash and short-term investments $ 878,012

    Accounts and current notes receivable 415,373Inventory 1,231,307Prepaid expenses 47,396

    Total current assets 2,572,088Property, plant and equipment

    DVD and video rental library $166,994Capital assets $1,001,640Less: Accumulated amortization 429,241 572,399

    Total property, plant, and equipment 739,393Intangible assets

    Trademarks, franchise licences and goodwill 3,789,744

    Total assets $7,101,225

    Solutions Manual 2-10 Chapter 2

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    EXERCISE 2-3

    (a) Net earnings = Revenues expenses= $18,180 780 5,360 2,600= $9,440

    Retained earnings = Beginning retained earnings + net earnings dividends= $40,000 + 9,440 0= $49,440

    (b)SUMMITS BOWLING ALLEY LTD.

    Balance SheetDecember 31, 2004

    AssetsCurrent assets

    Cash $20,840Accounts receivable 14,520Prepaid insurance 4,680

    Total current assets $ 40,040Property, plant and equipment

    Land $61,200Building $105,800Less: Accumulated

    amortization 45,600 60,200Equipment $82,400Less: Accumulated

    amortization 18,720 63,680Total property, plant andequipment 185,080

    Total assets $225,120

    Liabilities and Shareholders' EquityCurrent liabilitiesAccounts payable $ 12,480Interest payable 3,600Current portion of long-term debt 13,600

    Total current liabilities $ 29,680

    Mortgage payable 80,000Total liabilities 109,680Shareholders' equity

    Common shares 66,000Retained earnings 0 49,440

    Total shareholders equity 115,440Total liabilities and shareholders' equity $225,120

    Solutions Manual 2-11 Chapter 2

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    EXERCISE 2-4

    THE JEAN COUTU GROUP (PJC) INC.Balance SheetMay 31, 2002

    Assets

    Current assetsAccounts receivable $231,142Inventories 515,483Prepaid expenses 8,493Other current assets 23,323

    Total current assets $ 778,441Investments 236,679Property, plant and equipment $572,712

    Less: Accumulated amortization 157,217

    Total property, plant and equipment 415,495Intangible assets $265,743

    Less: Accumulated amortization 60,479 205,264Other assets 25,726Total assets $1,661,605

    Liabilities and Shareholders' Equity

    Current liabilitiesBank overdraft and bank loans $ 46,360

    Accounts payable 296,044

    Income taxes payable 10,106Current portion of long-term debt 32,618

    Total current liabilities $ 385,128Long-term debt 324,083Other long-term debt 6,335

    Total liabilities 715,546Shareholders' equity

    Capital stock $203,763Other shareholders equity 20,711Retained earnings 721,585

    Total shareholders equity 946,059

    Total liabilities and shareholders' equity $1,661,605

    Solutions Manual 2-12 Chapter 2

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    EXERCISE 2-5

    (a)BATRA CORPORATION

    Statement of EarningsYear Ended July 31, 2004

    RevenuesCommission revenue $73,100Rent revenue 18,300

    Total revenues 91,400Expenses

    Salaries expense 48,700Rent expense 10,800Utilities expense 4,900

    Amortization expense 3,975Total expenses 68,375

    Earnings before income taxes 23,025Income tax expense 8,000Net earnings $15,025

    BATRA CORPORATIONStatement of Retained Earnings

    Year Ended July 31, 2004

    Retained earnings, August 1, 2003 $25,200Add: Net earnings 15,025

    40,22550Less: Dividends 4,000

    Retained earnings, July 31, 2004 $36,225

    Solutions Manual 2-13 Chapter 2

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    EXERCISE 2-5 (Continued)

    (b)BATRA CORPORATION

    Balance SheetJuly 31, 2004

    Assets

    Current assetsCash $12,795Short-term investments 20,000

    Accounts receivable 18,780Supplies 1,500

    Total current assets $53,075Property, plant and equipment

    Equipment $19,875

    Less: Accumulated amortization 7,950Total property, plant and equipment 11,925

    Total assets $65,000

    Liabilities and Shareholders' Equity

    Current liabilitiesAccounts payable $ 6,220

    Long-term note payable 2,555Total liabilities 8,775

    Shareholders' equity

    Common shares $20,000Retained earnings 36,225

    Total shareholders equity 56,225Total liabilities and shareholders' equity $65,000

    Solutions Manual 2-14 Chapter 2

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    EXERCISE 2-6

    (a) and (b)

    2004 2003

    Earnings per share:

    shares67,000

    $2,000-$58,500

    = $0.84 per share

    Earnings per share:

    shares69,000

    $2,000-$81,000

    = $1.15 per share

    Price-earnings ratio:

    $0.84

    $10.00= 11.9 times

    Price-earnings ratio:

    $1.15

    $9.00= 7.8 times

    (c) The company was less profitable in 2004 than in 2003 as evidenced by its lower earningsand earnings per share. However, given the increase in the price-earnings ratio,investors still seemed to have a positive opinion about the future earnings prospects ofthe company despite the decline in the earnings per share.

    (d) A potential investor may be more concerned about he decline in earnings per share andwonder if the higher price-earnings ratio might mean that the share price is to high andlikely to fall in the near future.

    Solutions Manual 2-15 Chapter 2

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    EXERCISE 2-7

    (a)

    2003 2002

    Working capital$(2,134)

    $32,617$30,483

    =

    $596

    $27,282$27,878

    =

    Current ratio

    $32,617

    $30,483= 0.943:1

    $27,282

    $27,878= 1.0402:1

    (b) The decline in the working capital and current ratio indicate that Wal-Marts liquiditydeteriorated in 2003.

    (c) For 2002, Wal-Marts current ratio is lower than the current ratio of both Sears and TheBay. Wal-Marts current ratio is also lower than the industry average. This would indicatethat Wal-Mart is less liquid than Sears, The Bay and the industry as a whole.

    Solutions Manual 2-16 Chapter 2

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    EXERCISE 2-8

    (a) Debt to total assets =assetsTotal

    debtTotal

    34%$1,656,248$564,8212002 ==

    30.4%$1,532,557

    $466,0172001 ==

    (b) Cash current debt coverage =sliabilitiecurrentAverage

    activitiesoperatingfromprovidedCash

    +

    2

    $437,946$551,540

    $117,716

    = 0.24 times

    Cash total debt coverage =sliabilitietotalAverage

    activitiesoperatingfromprovidedCash

    +

    2

    $466,017$564,821

    $117,716

    = 0.23 times

    (c) The Carnivals solvency, a measure of its ability to survive over the long-term, has

    deteriorated in 2002 versus 2001. Its debt to total assets ratio increased from 30.4% in2001 to 34% in 2002. This means that in 2002, 34% of its assets were financed throughdebt compared to 30.4% in 2001.

    (d) In 2002, Carnival generated sufficient cash from its operating activities ($117,716) toprovide for the full amount of cash used in investing activities in the year ($107,393). Hadthere been a deficiency, the deficiency could have been provided for out of cash theorganization had on hand at the beginning of the year. Alternatively, any deficiency couldhave been covered through financing activities such as issuing debt.

    Solutions Manual 2-17 Chapter 2

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    SOLUTIONS TO PROBLEMS

    PROBLEM 2-1A

    (a) Generally accepted accounting principles are the accounting rules that havesubstantial authoritative support and are recognized as a general guide forfinancial reporting in Canada. In Canada, the primary responsibility for thedevelopment of the generally accepted accounting principles rests with theCanadian Institute of Chartered Accountants and is codified in the CICAHandbook.

    (b) Financial reporting is the term used to describe all of the financial informationpresented by a company both in its financial statements and in additionaldisclosures in the annual report. The basic objective of financial reporting is tocommunicate information that is useful to investors, creditors and others inmaking investment and lending decisions and in assessing managementperformance.

    (c) In order for information provided in financial statements to be useful, it mustbe understood by the users. Many investors may not understand detailedscientific findings. While scientific findings, knowledgeable employees and

    good customer relationships are important to business, these are non-financial performance measures. As such, they are not part of the financialreport. The information is relevant to users, but may not necessarily becapable of being reliably measured. The fourth qualitative characteristic,comparability, is not specifically addressed here.

    Solutions Manual 2-18 Chapter 2

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    PROBLEM 2-2A

    (a) Sears may feel that reporting its cost of merchandise sold separately in its

    financial statements may provide its competitors with useful information. Thelack of disclosure in this area makes it more difficult for users of the financialstatements to evaluate the companys performance.

    (b) The two constraints in accounting are:

    1. the cost-benefit constraint, which ensures that the value of the informationexceeds the cost of providing it; and

    2. materiality relates to a financial statement items impact on a companys

    overall financial condition and operations.

    Neither of these constraints likely impact Sears reporting policy with respectto cost of goods sold. Sears may round its financial statements to the nearestthousand dollars based on the materiality constraint.

    Sears could hire more security guards, put in more security monitors, countinventory daily, etc. as ways to monitor and control inventory theft. While theydo some of these, at some point the cost exceeds the benefit.

    Solutions Manual 2-19 Chapter 2

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    PROBLEM 2-3A

    Account Financial Statement Classification

    Accounts payable Balance Sheet: current liabilities

    Accounts receivable Balance Sheet: current assets

    Accum. amortization, building Balance Sheet: property, plant andequipment

    Accum. amortization, equipment Balance Sheet: property, plant andequipment

    Amortization expense Statement of Earnings: expense

    Building Balance Sheet: property, plant andequipment

    Cash Balance Sheet: current assetsCommon shares Balance Sheet: shareholders' equity

    Cost of goods sold Statement of Earnings: expense

    Current portion of long-term debt Balance Sheet: current liabilities

    Dividends Statement of Retained Earnings

    Equipment Balance Sheet: property, plant ande ui ment

    Income tax expense Statement of Earnings: expense

    Income taxes payable Balance Sheet: current liabilitiesInterest expense Statement of Earnings: expense

    Inventories Balance Sheet: current assets

    Land Balance Sheet: property, plant andequipment

    Long-term debt Balance Sheet: long-term liability

    Prepaid expenses Balance Sheet: current assets

    Retained earnings, beginning of year Statement of Retained Earnings

    Sales Statement of Earnings: revenue

    Selling expenses Statement of Earnings: expense

    Short-term investments Balance Sheet: current assets

    Wages payable Balance Sheet: current liabilities

    Solutions Manual 2-20 Chapter 2

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    PROBLEM 2-4A

    INTRAWEST CORPORATIONBalance SheetJune 30, 2002

    (thousands)

    AssetsCurrent assets

    Cash and cash equivalents $ 76,689Amounts receivable 109,948Other current assets 495,170

    Total current assets $ 681,807Investment properties 468,218Property, plant and equipment

    Ski and resort operations $1,125,603Less: Accumulated amortization,Ski and resort operation 283,762

    Total property, plant and equipment 841,841Goodwill 15,985Other noncurrent assets 159,066Total assets $2,166,917

    Liabilities and Shareholders' EquityCurrent liabilities

    Bank and other indebtedness,current portion $282,047Amounts payable 195,254Other current liabilities 99,484

    Total current liabilities $ 576,785Long-term liabilities

    Long-term liabilities $138,991Bank and other indebtedness,noncurrent portion 773,872

    Total long-term liabilities 912,863

    Total liabilities 1,489,648Shareholders' equity

    Capital stock $466,899Retained earnings 210,370

    Total shareholders equity 677,269Total liabilities and shareholders' equity $2,166,917

    Solutions Manual 2-21 Chapter 2

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    (a)BEAULIEU LIMITED

    Statement of EarningsYear Ended December 31, 2004

    Service revenue $82,000Expenses

    Repair expense 3,200Salaries expense 36,000Rent expense 18,000Utilities expense 3,700

    Insurance expense 1,200Amortization expense 7,000

    Total expenses 69,100Earnings before income taxes 12,900Income tax expense 6,500Net earnings $ 6,400

    BEAULIEU LIMITED

    Statement of Retained EarningsYear Ended December 31, 2004

    Retained earnings, January 1 $14,000Add: Net earnings 6,400

    20,400Less: Dividends 2,200

    Retained earnings, December 31 $18,200

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    PROBLEM 2-5A

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    PROBLEM 2-5A (Continued)

    (b)BEAULIEU CORPORATION

    Balance SheetDecember 31, 2004

    AssetsCurrent assets

    Cash $ 8,200Temporary investments 15,400

    Accounts receivable 7,500Prepaid insurance 1,800

    Total current assets $32,900Property, plant and equipment

    Equipment $32,000Less: Accumulated amortization 10,500

    Total property, plant and equipment 21,500Total assets $54,400

    Liabilities and Shareholders' EquityCurrent liabilitiesAccounts payable $12,000Salaries payable 3,000Income taxes payable 1,200

    Total current liabilities $16,200Shareholders' equity

    Common shares $20,000Retained earnings 18,200Total shareholders equity 38,200

    Total liabilities and shareholders' equity $54,400

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    (a)COMMERCE CRUSADERS INC.

    Statement of EarningsYear Ended April 30, 2004

    Sales $34,000Expenses

    Cost of goods sold 9,900Operating expense 4,400Wages expense 7,000

    Amortization expense 4,000Interest expense 4,000

    Total expenses 29,300Earnings before income tax 24,5004,700Income tax expense 1,350Net earnings $ 23,1503,350

    COMMERCE CRUSADERS INC.Statement of Retained Earnings

    Year Ended April 30, 2004

    Retained earnings, May 1 $10,150Add: Net earnings 23,1503,350

    33,30013,500Less: Dividends 3,250Retained earnings, April 30 $30,05010,250

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    PROBLEM 2-6A

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    PROBLEM 2-6A (Continued)

    (b) COMMERCE CRUSADERS INC.

    Balance SheetApril 30, 2004

    AssetsCurrent assets

    Cash $ 5,700Short-term investments 12,000

    Accounts receivable 8,100Inventories 9,670Prepaid expenses 120

    Total current assets $35,590Property, plant and equipment

    Land 14,000Building $15,370Less accumulated amortization, building 1,500 13,870Equipment $12,200Less accumulated amortization, equipment 5,000 7,200

    Total property, plant and equipment 35,070Total assets $70,660

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    PROBLEM 2-6A (Continued)

    Liabilities and Shareholders' Equity

    Current liabilitiesAccounts payable $8,340Wages payable 2,220Income taxes payable 1,350Current portion of long-term debt 4,500

    Total current liabilities $16,410Long-term liabilities

    Notes payable 35,000Total liabilities 51,410

    Shareholders' equity

    Common shares $ 9,000Retained earnings 30,050 10,250

    Total shareholders equity 39,05019,250Total liabilities and shareholders' equity $90,46070,660

    (c)The statement of earnings reports the net earnings for the period. This figure isthen used in the statement of retained earnings, along with dividends tocalculate the amount of retained earnings at the end of the period. The

    retained earnings figure is used in the balance sheet to complete theaccounting equation.

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    (a) Earnings per share:

    sharescommonofnumberAveragedividendsPreferred-earningsNet

    Belliveau Shields

    shareper$0.18shares200,000

    $36,000=

    shares400,000

    $173,000= $0.43 per share

    Shields Corp. appears to be more profitable than Belliveau as it has higherearnings per share.

    Price-earnings Ratio:

    shareperEarnings

    shareperpriceMarket

    Belliveau Shields

    times13.89$0.18

    $2.50=

    $0.43

    $7.00= 16.3028 times

    Investors appear to have more confidence in the earnings and profitability ofShields Corp. since the company has a higher earnings per shareprice-earnings ratio than Belliveau Corp.

    (b) Current Ratio:

    sliabilitieCurrentassetsCurrent

    Belliveau Shields

    1:2.2$60,000$130,000 = 1:2.8

    $250,000$700,000

    =

    Shields 2004 current ratio of 2.8:1 is higher than Belliveaus current ratio of2.2:1, which suggests that Shields is slightly more liquid than Belliveau.

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    PROBLEM 2-7A

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    PROBLEM 2-7A (Continued)

    (b) (Continued)

    Cash current debt coverage ratio:

    sliabilitiecurrentAverage

    activitiesoperatingfromprovidedCash

    Belliveau Shields

    +

    2

    $52,000$60,000

    $20,000

    = 0.4 times

    +

    2

    $275,000$250,000

    $185,000

    = 0.7 times

    Shields ratio of 0.7 times versus Belliveaus measure of 0.4 times suggeststhat Shields is the more liquid of the two companies.

    (c) Debt to total assets:

    assetsTotal

    debtTotal

    Belliveau Shields25.3%

    $435,000

    $110,000a= 30%

    $1,500,000

    $450,000b=

    Belliveau appears to be more solvent. Belliveaus 2004 debt to total assetsratio of 25.3% is lower than Shields ratio of 30%. The lower the percentage ofdebt to total assets, the lower the risk that a company may be unable to payits debts as they come due.

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    PROBLEM 2-7A (Continued)

    (c) (Continued)

    Cash total debt coverage ratio:

    sliabilitietotalAverage

    activitiesoperatingfromprovidedCash

    Belliveau Shields

    +

    2

    $120,000$110,000

    $20,000c

    = 0.2 times

    +

    2

    $425,000$450,000

    $185,000d

    = 0.4 times

    Shields cash total debt coverage ratio of 0.4 times suggests that Shields ismore solvent than Belliveau, which has a ratio of 0.2 times.

    a Total liabilities: $110,000 ($60,000 + $50,000) is Belliveaus 2004 totalliabilities.

    Total assets: $435,000 ($130,000 + $305,000) is Belliveaus 2004 totalassets.

    b Total liabilities: $450,000 ($250,000 + $200,000) is Shields 2004 totalliabilities.

    Total assets: $1,500,000 ($700,000 + $800,000) is Shields 2004 total assets.

    c Total liabilities: $120,000 ($52,000 + $68,000) is Belliveaus 2003 totalliabilities.

    d Total liabilities: $425,000 ($275,000 + $150,000) is Shields 2003 totalliabilities.

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    PROBLEM 2-8A

    (a) Current ratio = $159,500$246,500

    = 2.21.55:1

    (c) Cash current debt coverage =

    +

    2$156,000$159,500

    $55,600

    = 0.52 35 times

    (d) Debt to total assets =$811,800

    $291,500= 35.9%

    (e) Cash total debt coverage =

    +2$276,000$291,500

    $55,600= 0.29 20 times

    (f) Earnings per share =shares7,000

    $82,900= $1.1811.84

    (g) Price-earnings ratio =$11.84

    $34.00= 28.82.9 times

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    Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Second Canadian Edition

    PROBLEM 2-9A(a)

    2004 2003

    1. Earnings per share:

    shares76,000

    $46,000

    = $0.60 per share

    Earnings per share:

    shares50,000

    $163,000

    = $3.26 per share

    2. Price-earnings ratio:

    $0.60

    $4.00= 6.6 times

    Price-earnings ratio:

    $3.26

    $6.00= 1.8 times

    3. Working capital:

    $122,000$98,000$80,000)$90,000($50,000

    =

    ++

    Working capital:

    $89,000$75,000$75,000)$65,000($24,000

    =

    ++

    4. Current ratio:

    $98,000

    $220,000= 2.24:1

    Current ratio:

    $75,000

    $164,000= 2.19:1

    5. Debt to total assets:

    $860,000

    $105,000$98,000 += 23.6%

    Debt to total assets:

    $654,000

    75,000$75,000 $+= 22.9%

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    PROBLEM 2-9A (Continued)

    (b) The underlying profitability of the corporation has declined as indicated by thedecline in earnings and earnings per share. However, the decline in earningsper share can also be attributed to some extent to the increase in the averagenumber of common shares from 50,000 in 2003 to 76,000 in 2004. It seemsinvestors still have confidence in the earnings of the company as the price-earnings ratio has improved despite the decline in profitability. However, theincrease in the P/E ratio may just be indicative of the fact that the shares areovervalued and may decline in the future.

    Despite the decline in earnings, the companys liquidity position improved in2004. Working capital increased by $33,000 ($122,000 - $89,000) and the

    working capital ratio increased from 2.19:1 to 2.24:1. This means thecompany now has more current assets on hand to repay its currently maturingobligations.

    Finally, Giasson Corporations solvency also appears to have remained fairlyconstant in 2004, as total assets are financed only 23.6% by debt in 2004versus 22.9% in 2003.

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    PROBLEM 2-10A

    (a) ($ in millions)

    Abitibi TembecWorkingCapital $225$1,415-$1,640 = $769.4$504.1-$1,273.5 =

    CurrentRatio

    $1,415

    $1,640= 1.16:1

    504.1$

    $1,273.5= 2.52:1

    Debt to

    TotalAssets $11,707

    $8,442 = 72.1% $4,138.8$2,771.2 = 67%

    Cash totaldebtcoverage $8,301

    $1,037= 0.125 times

    $2,303.8

    $173.6= 0.08 times

    Earningsper share

    shares440

    $289

    = $0.66 per share shares82

    $77.9

    = $0.95 per share

    Price-earningsratio $0.66

    $11.63= 17.6 times

    $0.95

    $10.10= 10.6 times

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    PROBLEM 2-10A (Continued)

    (b) (Continued)

    Liquidity

    With a current ratio of 1.16 Abitibi appears to be less liquid then both Tembecand the industry. Tembecs current ratio of 2.52:1 is better than the industryaverage of 1.23:1. Overall, Tembec is more liquid than both Abitibi and theindustry.

    Profitability

    Tembec is more profitable than Abitibi in that it has higher earnings per share.

    Also, both companies have higher earnings per share than the industry.However, investors appear to have more confidence in the earnings of Abitibias evidenced by Abitibis price-earnings ratio. However, a high price-earningsratio may indicate that Abitibis shares are overpriced. Both companies havea lower price-earnings ratio than the industry.

    Solvency

    When looking at the debt to total asset ratio, Tembec appears to be more

    solvent than Abitibi as less of Tembecs assets are financed by debt.However, Abitibi seems to be able to generate more cash form operations thatcan be used to repay their liabilities as evidenced by Abitibis higher cash totaldebt coverage ratio.

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    PROBLEM 2-1B

    (a) The primary objective of financial reporting is to provide information fordecision making. In reporting the financial results of the company the financialstatements meet some of the investors need. There is other information thatinvestors need that is not part of the financial reporting package such as plansfor future growth and the experience of the management team.

    (b) Investors buy Net Nannys shares despite the losses because they expect thecompany to do well in the long-term. This does not mean that the informationin the financial statements is not reliable or relevant. It does confirm that thereis additional information, not contained in a companys financial statements,

    that investors use when making investment decisions.

    (c) The change in reporting currency will make the information easier for someinvestors to use. It will be easier to compare Net Nannys results to similar UScompanies. It will be necessary for Net Nanny to restate its previous yearsstatements for comparability.

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    PROBLEM 2-2B

    The two constraints in accounting are:

    1. the cost-benefit constraint, which ensures that the value of the informationexceeds the cost of providing it; and

    2. materiality relates to a financial statement items impact on a companysoverall financial condition and operations.

    The Empire Company Limited has almost ten billion dollars in revenue. The typeof information that Ryan is looking for, such as sales and cost data by variouscategories, is generally not disclosed in external financial statements. It would beprohibitively expensive to present such information to external users, and have it

    verified by external auditors. The company quite likely has internal reports withdata on various ticket and concession sales. However, the information used bymanagement is not always material to external users. As well, companies like toguard against disclosure of information if doing so would weaken their competitiveposition.

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    PROBLEM 2-3B

    Account Balance Sheet Category

    Accounts payable and accrued liabilities Current liabilitiesAccounts receivable Current assetsBuildings Property, plant and equipmentCash and cash equivalents Current assetsCommon shares Shareholders equityCustomers deposits Current liabilitiesDividends payable Current liabilitiesFuture income tax liabilities Current liabilities or long-term

    liabilitiesIncome taxes recoverable Current assetsInventory Current assetsLand Property, plant and equipmentLeasehold improvements Property, plant and equipmentLong-term liabilities Long-term liabilitiesMarketable securities Current assetsRetained earnings Shareholders equityVehicles Property, plant and equipment

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    PROBLEM 2-4B

    YAHOO! INC.Balance Sheet

    December 31, 2002

    AssetsCurrent assets

    Cash and cash equivalents $310,972Short-term investments 463,204

    Accounts receivable 113,612Prepaid expenses and

    other current assets 82,216Total current assets $ 970,004

    Long-term investments 763,408Property and equipment, net 371,272Intangible assets, net 96,252Goodwill 415,225Other assets 174,020Total assets $2,790,181

    Liabilities and Shareholders EquityCurrent liabilities

    Accounts payable $ 18,738Deferred revenuecurrent 135,501Accrued expenses and

    other current liabilities 257,575Total current liabilities $ 411,814

    Other liabilities 116,097Total liabilities 527,911

    Shareholders equityCommon stock $2,270,845Other shareholders equity (1,082)

    Deficit (7,493)Total shareholders equity 2,262,270

    Total liabilities and shareholders equity $ 2,790,181

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    PROBLEM 2-5B (Continued)

    (b)

    MBONG CORPORATIONBalance SheetDecember 31, 2004

    AssetsCurrent assets

    Cash $13,600Accounts receivable 13,500Supplies 1,000Prepaid insurance 3,500

    Total current assets $31,600Investments 22,300Property, plant and equipment

    Equipment $13,000Less: Accumulated amortization 5,600

    Total property, plant and equipment 7,400Total assets $61,300

    Liabilities and Shareholders' EquityCurrent liabilitiesAccounts payable $13,300Salaries payable 3,000

    Total current liabilities $16,300Note payable 5,000

    Total liabilities 21,300Shareholders' equity

    Common shares $20,000Retained earnings 20,000

    Total shareholders equity 40,000Total liabilities and shareholders' equity $61,300

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    PROBLEM 2-6B

    (a)

    CHEUNG CORPORATIONStatement of EarningsYear Ended April 30, 2004

    Fee revenue $32,590Expenses

    Salaries expense 6,840Rent expense 6006,000Interest expense 342

    Amortization expense 4,610Total expenses 12,39217,792

    Earnings before income taxes 20,19814,798Income tax expense 4,500Net earnings $15,69810,298

    CHEUNG CORPORATIONStatement of Retained Earnings

    Year Ended April 30, 2004

    Retained earnings, May 1, 2003 $13,960Add: Net earnings 15,69810,298

    29,65824,258Less: Dividends 3,650

    Retained earnings, April 30, 2004 $26,00820,608

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    PROBLEM 2-6B (Continued)

    (b)CHEUNG CORPORATION

    Balance Sheet

    April 30, 2004

    AssetsCurrent assets

    Cash $20,263Short-term investments 16,40011,000

    Accounts receivable 7,840Prepaid rent 500

    Total current assets $45,00339,603Property, plant and equipment

    Equipment $23,050Less: Accumulated amortization 9,220

    Total property, plant and equipment 13,830Total assets $58,83353,433

    Liabilities and Shareholders' EquityCurrent liabilitiesAccounts payable $5,972Interest payable 28

    Income taxes payable 1,125Total current liabilities $ 7,125Notes payable 5,700

    Total liabilities 12,825Shareholders' equity

    Common shares $20,000Retained earnings 26,00820,608Total shareholders equity 46,00840,608

    Total liabilities and shareholders' equity $58,83353,433

    (c) The statement of earnings reports the net earnings for the period. This figureis then used in the statement of retained earnings, along with dividends tocalculate the amount of retained earnings at the end of the period. Theretained earnings figure is used in the balance sheet to complete theaccounting equation.

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    PROBLEM 2-7B

    (a) Earnings per share:

    sharescommonofnumberAveragedividendsPreferred-earningsNet

    Chen Cassie

    shares100,000

    $311,630=$3.12 per share

    shares50,000

    $113,040= $2.26 per share

    Chen Corporation appears to be more profitable than Cassie as it has higherearnings per share.

    Price-Earnings Ratio:

    shareperEarnings

    shareperpriceMarket

    Chen Cassie

    times8.0$3.12

    $25.00=

    $2.26

    $14.00= 6.2 times

    Investors appear to have more confidence in the earnings and profitability ofChen Corporation since the company has a higher price-earnings ratio thanCassie Corporation.

    (b) Working Capital:

    Current assets current liabilities

    Chen Cassie

    $359,650$66,325$425,975 = $154,878$35,458$190,336 =

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    PROBLEM 2-7B (Continued)

    (b) (Continued)

    Current Ratio:

    sliabilitieCurrentassetsCurrent

    Chen Cassie

    1:6.4$66,325

    $425,975= 1:5.4

    $35,458

    $190,336=

    Chens 2004 current ratio of 6.4:1 is higher than Cassies current ratio of

    5.4:1, which suggests that Chen is slightly more liquid than Cassie.

    Cash current debt coverage ratio:

    sliabilitiecurrentAverage

    activitiesoperatingfromprovidedCash

    Chen Cassie

    +

    2

    $75,815$66,325

    $162,594

    = 2.3

    +

    2

    $30,281$35,458

    $24,211

    = 0.7

    Chens cash current debt coverage ratio of 2.3 times is 3 times that of Cassie,showing that Chen is more liquid.

    (c) Debt to total assets:

    assetsTotal

    sliabilitieTotal

    Chen Cassie

    18.5%$947,285$174,825

    a= 19.7%

    $330,064$65,078

    b=

    PROBLEM 2-7B (Continued)

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    (c) (Continued)

    Chen appears to be slightly more solvent. Chens 2004 debt to total assetsratio of 18.5% is lower than Cassies ratio of 19.7%. The lower the percentageof debt to total assets, the lower the risk that a company may be unable to pay

    its debts as they come due.

    Cash total debt coverage ratio:

    sliabilitietotalAverage

    activitiesoperatingfromprovidedCash

    Chen Cassie

    +

    2

    $165,815$174,825

    $162,594c

    = 0.95

    +

    2

    $55,281$65,078

    $24,211d

    = 0.4

    Chens cash total debt coverage ratio of 0.95 times also suggests that Chen ismore solvent than Cassie, which has a ratio of 0.4 times.

    a Total liabilities: $174,825 ($66,325 + $108,500) is Chens 2004 total liabilities.

    Total assets: $947,285 ($425,975 + $521,310) is Chens 2004 total assets.

    b Total liabilities: $65,078 ($35,458 + $29,620) is Cassies 2004 total liabilities.

    Total assets: $330,064 ($190,336 + $139,728) is Cassies 2004 total assets.

    c Total liabilities: $165,815 ($75,815 + $90,000) is Chens 2003 total liabilities.

    d Total liabilities: $55,281 ($30,281 + $25,000) is Cassies 2003 total liabilities.

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    (a) Working capital = $302,400$142,500$444,900 =

    (b) Current ratio =$142,500

    $444,900= 1.83.1:1

    (c) Cash current debt coverage =

    +

    2$107,400$142,500

    $74,900

    = 01.09.60 times

    (d) Debt to total assets =$1,070,200$452,500 = 42.43%

    (e) Cash total debt coverage =

    +2$307,400$452,500

    $74,900

    = 0.50 20 times

    (f) Earnings per share =shares50,000

    $122,300= $2.45

    (g) Price-earnings ratio =$2.45

    $7.00= 12.24 2.9 times

    Solutions Manual 2-46 Chapter 2

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    PROBLEM 2-8B

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    PROBLEM 2-9B

    (a)

    2004 2003

    1. Earnings per share:

    shares82,000

    $94,000

    = $1.15 per share

    Earnings per share:

    shares80,000

    $52,000

    = $0.65 per share

    2. Price-earnings ratio:

    $1.15

    $66.00= 57.4 times

    Price-earnings ratio:

    $0.65

    $44.00= 67.7 times

    3. Working capital:

    $110,000$75,000-

    90,000)$70,000$$(25,000

    =

    ++

    Working capital:

    $75,000$80,000-

    70,000)$65,000$$(20,000

    =

    ++

    4. Current ratio:

    $75,000

    $185,000= 2.46:1

    Current ratio:

    $80,000

    $155,000= 1.94:1

    5. Debt to total assets:

    $760,000

    $86,000$75,000+= 21.2%

    Debt to total assets:

    $685,000

    $110,000$80,000+= 27.7%

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    PROBLEM 2-9B (Continued)

    (b) The underlying profitability of the corporation has improved as evidenced bythe improvement in earnings and earnings per share. However, it seems

    investors have less confidence in the future earnings of the company as theprice-earnings ratio has declined despite the increase in profitability.

    The companys liquidity position improved in 2004. Working capital increasedby $35,000 ($110,000 - $75,000) and the current ratio increased from 1:94:1to 2.46:1. This means the company now has more current assets on hand torepay its currently maturing obligations.

    Finally, Pitka Corporations solvency also appears to have improved in 2004,as total assets are financed only 21.2% by debt in 2004 versus 27.7% in 2003.

    The lower the percentage of debt to total assets, the lower the risk that acompany may be unable to pay its debts as they come due.

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    (a) ($ in thousands)

    Big Rock SleemanWorkingcapital $1,134.4$5,357.9-$6,492.3 = $1,804$46,315-$44,511 =

    Currentratio

    $5,357.9

    $6,492.3= 1.21:1

    $46,315

    $44,511= 0.96:1

    Debt tototalassets $33,060.7

    $11,276.6= 34.1%

    $197,642

    $124,554= 63%

    Cashcurrentdebtcoverage

    $4,916.8

    $2,580.5= 0.52 times

    $43,044.5

    $18,984

    = 0.44 times

    Cash total

    debtcoverage $11,792.3$2,580.5

    = 0.22 times $122,089.5$18,984

    = 0.15 times

    Earningsper share

    shares5,167.7

    $1,217.8

    = $0.24 per share

    shares15,223

    $9,765

    = $0.64 per sharePrice

    earningsratio $0.24$5.50

    = 22.9 times $0.64$9.73

    = 15.2 times

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    PROBLEM 2-10B

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    PROBLEM 2-10B (Continued)

    (b) Liquidity

    With a current ratio of 1.21 Big Rock appears to be more liquid than bothSleeman and the industry. Sleemans current ratio of 0.96 is even less thanthe industry average of 1.18:1. As well, Big Rock has been able to generatemore cash to repay it current liabilities as indicated by Big Rocks higher cashcurrent debt coverage ratio. Overall, it appears that Big Rock is more liquidthan both Sleeman and the industry.

    Profitability

    Sleeman is more profitable than Big Rock in that it has a higher earnings per

    share. However, investors appear to have more confidence in the earnings ofBig Rock as evidenced by Big Rocks higher price-earnings ratio. Bothcompanies have higher earnings per share than the industry. However, bothcompanies have a much lower price-earnings ratio than the industry.

    Solvency

    Big Rock appears more solvent than Sleeman. It betters Sleeman in the debtto total assets ratio and in the cash total debt coverage ratio.

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    BYP 2-1 FINANCIAL REPORTING PROBLEM

    (a) Total current assets were $3,526,000,000 at December 28, 2002, and $3,086,000,000 atDecember 29, 2001.

    (b) Current assets are properly listed in the order of liquidity. As you will learn in a later chapter,inventories are considered to be less liquid than receivables. They are listed belowreceivables and before prepaid expenses.

    (c) The asset classifications are similar to the text: current assets, followed by non-currentassets such as fixed assets, goodwill, future income taxes and other assets.

    (c) Total current liabilities were $3,154,000,000 at December 28, 2002, and $2,796,000,000 atDecember 29, 2001.

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    BYP 2-2 COMPARATIVE ANALYSIS PROBLEM

    (a)Loblaw (millions) Sobeys (millions)

    1. Working capital

    $372$3,154-$3,526 = $86.1$1,180.5-$1,094 =

    2. Current ratio

    1.12$3,154

    $3,526= :1 1:0.93

    $1,180.5

    $1,094.4=

    3. Debt to totalassets

    63%$11,110

    $6,986= 55%

    $3,192.5

    $1,755.7=

    4. Earnings pershare

    $2.64shares276.2

    $728= $2.72

    shares65.9

    $179.0=

    5. Price-earningsratio

    $2.64

    $54.00= 20.5 times

    $2.72

    $36.75= 13.5 times

    (b) Sobeys has a negative working capital and a current ratio of less than one. Loblaw has apositive working capital and a current ratio which indicates the company has sufficientassets to cover its current liabilities. Using these ratios it appears that Sobeys is in worsecondition based on relative liquidity.

    Based on the debt to total assets ratio it appears that Loblaw is less solvent than Sobeys.Because Sobeys debt to total assets ratio is lower than Loblaws, Sobeys would beconsidered better able to pay its debts as they come due.

    Based on earnings per share Sobeys appears to be more profitable than Loblaw. Sobeyshas been able to generate $2.72 in earnings for each common share while Loblaw hasonly generated $2.64. However, as indicated by the higher price earnings ratio, investorsappear to have more confidence in Loblaws earnings and relatively seem to be willing topay more for Loblaws shares.

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    BYP 2-4 INTERPRETING FINANCIAL STATEMENTS

    (a) The percentage increase in The Gaps total assets during this period is calculated as:

    $3,964$3,964$9,902 = 150%

    The average increase per year can be approximated as:

    years4

    150%= 37.5% per year

    (b) The Gaps working capital increased significantly during this period, whileits current ratio also improved. The improvement in the current ratio would suggest thatThe Gaps liquidity improved. The current ratio is a better measure of liquidity because it

    provides a relative measure; that is, current assets compared to current liabilities. Workingcapital only tells us the net amount of current assets and current liabilities. It is hard to saywhether a given amount of working capital is adequate or inadequate without knowing thesize of the company. Another problem with interpreting The Gaps working capital is that itfluctuated considerably during the period. The Gaps current ratio may have improvedbecause the clothing chain expanded rapidly during this period. With expansion comes theneed to carry additional inventories which is a significant component of current assets.

    (c) The debt to total assets ratio suggests that The Gaps solvency declined during the period,as the percentage of debt used to finance its assets increased. However, this could bedue to the additional funds required to finance the companys growth over the past several

    years.

    (d) The companys earnings per share have decreased over the past several years. Theaverage earnings per share from 1998 to 2000 2002 was:

    $0.775

    $0.95]$1.32$1.03$(0.01)[$0.55=

    ++++

    On the average, earnings per share has declined which might cause some investors tohave concerns about the companys future prospects. However, investors would needinformation concerning the change in the number of common shares outstanding to fully

    assess the earnings per share, as the decline in EPS could be related to increases in thenumber of shares rather than decreases in profitability.

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    BYP 2-5 A GLOBAL FOCUS

    (a) By switching to US reporting standards, a companys statements would be more relevant tothe companys US investors (present and potential). This may make it easier for them toraise funds in the US, a much larger capital base than Canada. It will make it easier for USinvestors to understand the statements because they will use standards that they arefamiliar with and it will be easier for them to make comparisons with US companies. Manynon-US companies use US standards. The disadvantages associated with such a changeinclude making it more difficult for Canadian investors to understand the statements andmake comparisons to companys using Canadian standards. It will also increase thefinancial reporting coststhe company will be required to reconcile the statement preparedusing the different standards. The impact of the switch on a companys net earnings couldbe either an advantage or disadvantage depending on the individual circumstance of thecompany.

    (b) The use of country specific accounting policies may hinder my comparison. When differentstandards are used the impact on reported earnings and financial performance can besignificant. In order to compare apples and apples, a conversion of one of the sets ofstatements may be required. This may require significant time and expertise. ManyCanadian companies include a reconciliation to US GAAP in their financial statements tohelp with this.

    (c) Comparison of Canadian companies that use different accounting policies would be difficultas the use of different standards policies can have a significant impact on reported earn-ings and financial performance.

    (d) There is no significant distinction between comparing statements prepared in differentcountries and statements prepared in the same country using different accounting policies.In either case the policies will have to be reconciled in order to make valid comparisons.

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    BYP 2-6 FINANCIAL ANALYSIS ON THE WEB

    Due to the frequency of change with regard to information available on the World Wide Web,the Accounting on the Web cases are updated as required. Their suggested solutions are also

    updated whenever necessary, and can be found in the Instructor Resources section of ourhomepage (www.wiley.com/canada/kimmel

    Solutions Manual 2-56 Chapter 2

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    http://www.wiley.com/canada/kimmelhttp://www.wiley.com/canada/kimmel
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    BYP 2-7 COLLABORATIVE LEARNING ACTIVITY

    The current ratio increase is a favourable indication as to liquidity, but alone tells little about theprospects of the client. From this ratio change alone, it is impossible to know the amount and

    direction of the changes in individual accounts, total current assets, and total current liabilities.Also unknown are the reasons for the changes.

    The working capital increase is also a favourable indication as to liquidity, but again the amountand direction of the changes in individual current assets and current liabilities cannot bedetermined from this measure.

    The decrease in the debt to total assets ratio is a favourable indicator for solvency and going-concern prospects. The lower the percentage of debt to total assets, the lower the risk that acompany may be unable to pay its debts as they come due. A decline in the debt to total assetsratio is also a positive sign regarding going-concern potential.

    The increase in net earnings is a favourable indicator for both solvency and profitabilityprospects although much depends on the quality of receivables generated from sales and howquickly they can be converted into cash. Indirectly, the improved income picture may have afavourable impact on solvency and going concern potential by enabling the client to borrowcurrently to meet cash requirements.

    The earnings per share increase is a favourable indicator for profitability. The fact that the EPSmore than doubled during the year indicates a significant increase in net earnings and providesa favorable sign regarding going concern potential. However, investors should check to ensurethat the increase in earnings per share was not due to a major decrease in the average number

    of common shares outstanding

    The increase in price-earnings ratio indicates that investors have confidence in the earnings ofthe company and are willing to pay a premium for the shares. However, investors may becautious about buying if the P/E ratio is too high as it may indicate that the companys sharesare overpriced.

    Overall, Soukups liquidity, solvency, and profitability do appear to be improving. Its liquidity hasimproved, although further investigation is warranted into receivables and inventory turnoversbefore concluding on this matter. The companys solvency has improved, with the decline in thedebt to total assets ratio. The companys profitability has also improved.

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    Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Second Canadian Edition

    BYP 2-8 COMMUNICATION ACTIVITY

    To: S.B. Barrett

    From: Accounting Major

    Subject: Financial Statement Analysis

    Ratios can be classified into three types, which measure three different aspects of a company'sfinancial health:

    (a) Liquidity ratiosThese measure a company's ability to pay its current obligations.

    Examples of liquidity ratios include the current ratio (current assets/current liabilities) andthe cash current debt coverage ratio (cash provided by operating activities/average current

    liabilities).

    (b) Solvency ratiosThese measure a company's ability to pay its long-term obligations andsurvive over the long-term.

    Examples of solvency ratios include the total debt and total assets ratio (total liabilities/totalassets) and the cash total debt coverage ratio (cash provided by operatingactivities/average total liabilities).

    (c) Profitability ratiosThese measure the ability of the company to generate a profit.

    Examples of profitability ratios include the earnings per share (net earnings - preferreddividends) (average number of common shares outstanding) and the price-earnings ratio(market price per common share earnings per share).

    There are three bases for comparing a company's results:

    (a) IntracompanyThis basis compares an item or financial relationship within a company inthe current year with the same item or relationship in one or more prior years.

    (b) Industry averagesThis basis compares an item or financial relationship of a companywith industry averages (or norms).

    (c) IntercompanyThis basis compares an item or financial relationship of one company withthe same item or relationship in one or more competing companies.

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    BYP 2-9 ETHICS CASE

    (a) The stakeholders in this case are:

    Kathy Johnston, controller.Redondos vice-president.Users of the company's financial statements.

    (b) The ethical consideration in the situation is whether or not the early implementation of thenew standard would affect the decisions of the users of the financial statements. Becauseearly adoption is only suggested and not required, the vice-president is fully within hisrights to delay implementation of the standard. However, it is ethically preferable todisclose the most financially relevant information to the users of the financial statements sothat they can make informed decisions.

    (c) As controller, by supporting early implementation Kathy could gain the trust and respect of

    the board of directors and the shareholders in general. The users of the companysfinancial statements will be affected by the decision against early implementation as theirdecision-making may be influenced by the presentation of the companys financial resultsusing the old standards.

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    Legal Notice

    Copyright

    Copyright 2004 by John Wiley & Sons Canada, Ltd. or related companies. All rights reserved.

    The data contained in these files are protected by copyright. This manual is furnished under licence and may beused only in accordance with the terms of such licence.

    The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, madeavailable on a network, used to create derivative works, or transmitted in any form or by any means, electronic,mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley &Sons Canada, Ltd.